The History of the Greek Crisis

I've done a piece of History Today about the Greek debt crisis. You can read it here.

France Will Be the Next Eurozone Victim

In my Money Week column this week, I argue that France may be the next country to fall to the euro crisis. Here is a taster.


The euro debt crisis increasingly resembles a teen horror movie. As soon as you think it is all over, the monster springs back to life. There is an unlimited number of sequels. And it usually ends up with a bloodbath.
This week it was the turn of Italy to be in the spotlight. The country’s bond yields started to spike upwards, a serious issue for a nation that has vast debts to pay the interest on. After flying under the radar for much of the crisis, the Italian debt market looks close to unravelling. Spain is coming under increasing scrutiny as well. It might well be next.
But in fact the markets are looking in the wrong place. True, there is plenty to worry about in both Italy and Spain. But the real testing ground for the euro is going to be their northern neighbour, France. It too is struggling to stay in the euro – and it, far more than Italy or Spain, has the potential to trigger a financial meltdown. France matters to the global financial markets far more than any of the other euro countries in trouble.
Monetary union was, of course, largely a French idea. The country’s industrial and financial establishment had long been unhappy with floating exchange rates. As one of the major exporters within the European Union, they could see that constantly shifting currencies made life very difficult for their companies. While Germany primarily exports to the rest of the world, France is a euro-zone manufacturing hub. A fixed currency system was very much in its interests. Indeed, one interpretation of the creation of the euro was that it was a deal between the French and the Germans: the Germans accepted merging their currency with France’s in exchange for French support for the re-unification of Germany after the fall of the Berlin Wall. It is ironic, therefore, that it isn’t working out the way France planned.
Could France seriously have a problem staying in the euro? After all, it is a big, successful economy. It is not a peripheral nation like Greece or Portugal, neither of which ever really industrialised, or a chronically financially chaotic country like Italy. Then again, Ireland was a successful, wealthy economy, and that didn’t stop the country going bust as a result of monetary union.
In reality, France is steadily losing competitiveness within the euro. That was confirmed last week with the latest trade data, which showed a widening deficit. The April trade gap rose to 7.42 billion euros. The UK, by contrast ran a deficit of £2.8 billion or 3.1 billion euros in April. The French deficit now amounts to 3% of GDP, and has been hitting fresh records month-by-month. France’s trade deficit with Germany, its main trading partner, is now one billion euros a month. “Within euroland, France is losing competitiveness to Germany, and it has no option for devaluation to help itself out,” noted Hi-Frequency Economics in an analysis of the figures. “A potential rift between France and Germany on trade would be a far more serious challenge to EMU’s political fabric than a disagreement over how to restructure loans to euroland’s second-smallest economy [Greece].”
Indeed so. There is no great mystery about what is happening. French wages have been rising at a faster rate than German wages, and their productivity is not as good. The country is steadily becoming a less attractive place to make things.
The important point is that persistent and rising trade deficits are clear evidence that France is struggling within the single currency in precisely the same way as the Greeks – it’s the same explosion, just with a much longer fuse. As it runs bigger and bigger deficits, the money will have to be re-cycled through the banking system. Eventually that will lead to a financial crisis.
It may happen sooner than anyone thinks. While a country such as Italy has a greater stock of out-standing debt, France is racking up new debts at a far faster rate. Last year it ran a deficit of 7% of GDP. French debt will total 90% of GDP this year and 95% in 2012 according to estimates by Capital Economics. That isn’t exactly running out of control – but it is getting very close.
There are other problems on the horizon. A Presidential election is due next year. That may turn into a competition for who can make the most extravagant promises. And the far-right National Front leader Marine Le Pen is pledged to bring back the franc. If she continues to do well in the polls, then pulling out of the euro will be on the agenda. That is not true of any other euro area country, not even Greece.
At any point, the bond markets may well take fright. They will start pricing in the possibility of France pulling out of the euro, or defaulting on some of its debt. Yields on French debt will start to spike upwards. And that will be the point at which the crisis turns scary.
While Greece, Portugal and Ireland don’t matter very much to the global capital markets, France does. In fact, it matters much more than Italy and Spain. It has $1.7 trillion of outstanding public debt, making it the fourth largest debtor in the world, according to data from the Bank for International Settlements. (The US, Japan and Italy are ahead of it). That debt is widely traded – 37% of French debt is held internationally, which is a lot more than Italy (24%), the US (19%) or Japan (1%), again on BIS figures. In truth, French bonds are held by institutions right around the world and have always been regarded as rock solid.
On current trends, that will have to change. France can no more survive in the euro-zone than Italy or Spain can. At some point, the bond markets are going to wake up to the problems in France. They are going to get very nervous about French debt, the same way they did about Greek and Portuguese and Spanish debt. They will start marking down the bonds, and factoring in potential default. But if that happens the losses to the financial system will be very nasty indeed. The euro was created in France. It may well be in France that it starts to finally unravel as well.

The British Monetary Union Isn't Working Either....

In my Money Week column this week, I've been looking at the the UK as a monetary union, like the euro....and concluding that doesn't work either. Here's a taster.


What does the euro need to make it work better? The most common answer is that it needs to be turned into a fiscal union, with large-scale transfers from the richer regions to the poorer. It is the conventional wisdom of every editorial, and City pundit. Until it becomes a ‘transfer union’ it doesn’t stand a chance of succeeding.
A caveat or two is usually thrown in. The political obstacles are formidable. The Germans might never agree to their taxes being sent to bail-out Greece or Portugal. The treaties might need to be re-written, and that would require the agreement of all the European Union’s members. Still, if only those obstacles could be overcome, a fiscal union would smooth out most of the problems.
The trouble is, no one seems to have stepped back and questioned the fundamental assumption. The evidence suggests it may well be wrong. Europe has another monetary union between countries at very different stages of economic development. It is called the UK, and the currency is sterling. Reverse the polarities – the UK has a rich south, and a poor north, rather than a rich north and a struggling south – and the sterling area has many similarities to the euro area. It is made up of group of countries with very different levels of prosperity. And it has huge transfers between the richer regions and the poorer.
And the result? It doesn’t do any good at all. True, it holds the currency area together. But it only does so at the cost of creating regions that are ever more dependent on state aid. The truth is, a transfer union won’t save the euro even if it was politically feasible. Nothing will. The project is doomed.
That doesn’t stop people from trying, The most common critique of the single currency is that is an economic union without a political union. George Soros has argued for a year that without a single government the currency won’t survive. The President of the European Central Bank Jean-Claude Trichet has called for a European finance ministry.
The UK’s experience, however, suggests that even if it happened, it wouldn’t work. Britain used to be a fairly homogenous economy, with wealth relatively evenly spread out across its major industrial centres, much as it is in modern Germany. Not any more. Post-industrial Britain has a very, very prosperous capital, surrounded by equally wealthy suburbs. The Midlands and East are doing fine. The rest of the country has been falling behind at an increasingly rapid rate. The result is that there are huge disparities between output per head in the South and Wales, Scotland and Northern Ireland. It isn’t quite as dramatic as the gulf between Germany and Greece – but it isn’t that far off.
That gets fixed by fiscal transfers. The UK, which has of course a single government, and single finance ministry, shuttles large sums of money from the richer regions to the poorer. Oxford Economics, the consultancy firm, has calculated the amount the British government spends per person employed – per taxpayer, in other words - for the different parts of the country. In the prosperous South-East, the government spent £14,100 per working person. In Northern Ireland, it spent £21,200. Wales, Scotland and the North-East were all way above average. The East, East Midlands, and London were all below average – although London, which has pockets of real poverty amidst its wealth, not by as much as you might think. It also looked at expenditure relative to gross value added, that is the actual output of the region. Taking the average for the UK as 100, Northern Ireland scored 155 and the South-East just 84. In other words, a lot of the wealth from the South-East gets sent to the ‘periphery’.
The UK is, therefore, a monetary union with very significant transfers between its richer and poorer regions. The trouble for the euro’s would-be fiscal unifiers is that there is very little evidence that it fixes the problem. Northern Ireland for example has had a consistently lower growth rate than the UK as a whole – this year, it will grow by 1.1% compared with 1.7% for the UK according to estimates by Northern Bank. Much the same is true of Wales and the North-East. The regions with the biggest fiscal transfers have grown consistently more slowly than the rest of the UK, with the result that the ratio of state spending relative to their local economies has grown steadily over time. Between 1999 and 2010 state spending rose from 50% of the Welsh economy to 69%, according to calculations by the Centre for Economics and Business Research.
Fiscal transfers can hold a monetary union together. There is no sign of the sterling area breaking up, although the Scots might eventually decide to go their own way. But they won’t close the gap between the richer regions and their poorer neighbours. They are a permanent subsidy – and one that will probably grow over time.
If anything, the fiscal transfers probably make the problem worse. They crowd out private investment – after all, why would anyone in Northern Ireland set up a business when they are relatively few industries where it has much strength, and when they could just get on a plane to London, or else get a secure job in the public sector? It creates whole regions where the fiscal transfers are the only thing that keeps the economy afloat.
That just about works in the UK. It has been a unified state for several hundred years, and has close ties of language, culture and family between its regions – although it remains to be seen whether the Tory voters of the south-east will accept the deal forever. But it is very hard to see it working for the euro zone. Voters in Munich and Eindhoven already seem outraged by paying for the Greeks and Portuguese. When they get told that the transfers are permanent, and will rise steadily over time, they will surely refuse to pay. The scary truth is that even the one plausibly fix for the euro crisis doesn’t work.

How The Euro Will End....

How will the euro actually come apart. I've been exploring that in my Market Watch column this week. You can read it here.

The Demise of the Euro....

In Management Today this month I've done a piece on the demise of the euro. You can read it here.

Britain & The Euro Break-Up

In my Money Week column this week I've been exploring how Britain should handle the potential break-up of the euro. Here's a taster.

It would be easy for the UK to stay smugly on the sidelines as the euro collapses. After all, Britain had to struggle not to join the single currency when it was launched. And it had to put up with years of European politicians warning that the City, and the vast earnings it brings into London, would be finished as result of its government’s stubborn scepticism. You hardly need to be German to think the word schadenfreude might be an apporiate way of desribing many people’s response on this side of the English channel.
That would be temptimg, but wrong. Britain has a huge amount at stake in the euro’s crisis. We are contributing billions to the bail-out of the Irish. The Spanish banks, which could well be the next domino to fall, have a massive presence in this country. The euro-zone is our largest trading partner.
If the euro-zone does break-up – and it looks increasingly likely that it will – then the way that it does so, and the currency system that replaces it, will matter hugely to the UK economy over the next decade. Britain should be leading that debate, And it should be arguing for an orderly break-up, returning to national currencies, but with the euro preserved as a business and financial currency.
The troubles of the euro are getting too severe for even its most enthusiatic proponents to ignore. The Greeks going bust was one thing. The Greeks fiddled their way into the system, and made no attempt to play by the rules. They should never have been allowed in, and, once inside, should have been told to reform fast, or get out again.
But Ireland is something different. It was one of the most suscessful economies in the world before it joined the euro. It did everything that was expected of it, cutting wages, and public spending with a ferocity that no other country has matched. Yet it still ran out of money. With two out of 16 euro countries needing bailing out, it is hard to see how the single currency cannot be blamed. Nor is it going to stop here. Portugal will be next, then Spain, and probably Belgium as well. After that, it is merely a qustion of whether the bond markets take France or Italy down first.
For the UK, that matters hugely. We are on the hook for a large chunk of the Irish bail-out. This county will contribute around eight billion euros to the bail-out package for the Irish government. Royal Bank of Scotland and Lloyds, the two partially state-owned British banks, have billlions in exposure to the Irish economy. If Ireland goes down, it will cost the UK huge sums.
It doesn’t just end there. The Spanish banks – most notably Santander – have a massive presence in the UK. If the Spain is the next euro domino to fall, we may end up regretting allowing a bank from that country to end up owning such a large chunk of the British financial system. Likewise, if Portuguese, or Belgium, or French banks get caught up in the crisis, that will have terrible consequences for our own banks, and for the City more widely.
And, of course, the euro-zone is Britain’s main trading partner. It is no use thinking we can simply be a spectator at this drama. The UK needs to get involved in trying to shape the way it plays out.
Of course, as an outsider the UK may struggle to be listened to. Against that, our foresight in staying out may give us a voice. After all, the architects of the euro, who assured us the single currency would protect Europe from chaos in the markets, are looking fairly foolish right now. And, in addition, Britain is one of the largest economies in Europe. All of that gives us a role to play.
So what should the UK be arguing for?
The first and most important point is that the UK should be pushing for an orderly break-up of the euro. The subject is still taboo in Brussels and Frankfurt. That is crazy. There is a real risk the euro may collapse amid chaos and turmoil. If confidence in Spain goes, it might happen very suddenly, taking France and Italy with it. After all, the exchange rate mechanism, the precursor to the euro, fell apart over the space of a few days in 1992. The euro could do the same. It would be far better if there was a calm and measured debate now about how to unravel it. Sensible decisions are rarely made during a few hours of fevered debate with the global markets in freefall.
There is plenty of talk about creating a northern and southern euro – a neuro and sudo (or the medi, as one Morgan Stanley analysis called it). That would fix some of the problems. The peripheral countries could devalue as a bloc against the stronger economies of core Europe. The two currency zones would be more compatible than the one that exists at the moment.
But will there really be any appetite for another monetary experiment after the failure of the euro? Probably not. Nor is it clear that the two zones would work much better than the one we have right now. France has been losing competitiveness steadily against Germany. It might struggle to stay in the neuro. The sudo would be led by its largest economy, Italy. How much confidence would the markets have in a currency zone led by the Italians? Yup, you guessed right – not very much. Even the Italians probably wouldn’t want to join.
The best solution would be to return to the national currencies. But it would be worth keeping the euro as a parallel currency – which is in fact what the British proposed when the euro was launched. The ECB could be jointly owned by the states of the EU, and the currency would be legal tender in every country. Over time, some of the smaller states might abandon their own currencies and just have the euro. But it would happen naturally, and from the ground up – not from the top down.
That would serve Britain’s interests best. But it isn’t going to happen unless we start arguing for it.

How To Break-Up The Euro....

In my Money Week column this week, I've been looking at how to break up the euro. Here's a taster....

There are two interesting questions to be asked about the euro right now. Does it have any chance of surviving in its current form? And, if not, how would you go about breaking up the single currency?
The euro can collapse in two ways. It can fall apart suddenly, overnight, in a chaotic scramble in which every country looks after itself. Or it can be split up in an orderly, organised way, in which the currency is slowly laid to rest, with the minimum possible disruption to the euro area’s economy. How? There are three ways. Germany could leave. You could create two euros, one for northern and one for southern Europe. Or, indeed, you could go back to the British proposal of the 1990s and have competing, parallel national currencies that would trade alongside the euro.
True, the euro might stagger on. It is too early to condemn the single currency to the lengthy list of failed monetary experiments. A sharp drop in the currency – and the markets are certainly doing their best at the moment to make sure that happens – might help the struggling, highly indebted members steady their economies for long enough to get their public finances back under control. The Germans might give up the habits of a generation and start spending rather than saving – and spend mostly on Greek and Spanish exports.
Who knows, miracles do happen – just not very often.
In reality, however, the experiment in joining Europe’s currencies together now looks doomed to failure. A system in which countries spend like crazy, run up massive public sector deficits, and then get someone else to pay the bill is plainly bonkers. The incentives are all wrong. Everyone has an interest in doing the crazy spending. No one has any incentive to do the bailing-out.
The euro could only work if you had strict limits on what governments could spend. The founders recognized that, and built it into the rules, but no one tried to enforce them. It is too late to fix that now. It is far better to recognize that, and think hard about breaking the currency up.
A chaotic, disorderly collapse wouldn’t help anyone. Greece could default, swiftly followed by Spain and Portugal. But terrible damage would be inflicted on the banks that were carrying their bonds on their books. The Germans could switch back to the deutschemark overnight – and the markets last month were briefly rocked by a conspiracy website that claimed to have pictures taken by a Deutsche Bank employee of the new German banknotes that had been secretly printed over a bank holiday weekend. But, either way, the markets would plunge. The impact on stock and bond prices would be finished, and could easily tip an already fragile global economy back into recession.
If the euro is finished, it would be far better to make sure it was quietly put to rest. So what are the options? Here are three to be thinking about.
First, Germany leaves. This option has been widely discussed in the markets ever since Morgan Stanley published a note on the possibility three months ago. It makes a lot of sense. One of the key problems with the euro is the overwhelming strength of the German economy compared with its neighbours. It is very hard for one of the weaker countries to leave to currency. All their debts are denominated in euros. If their currency collapsed, as it surely would, those debts would soar even higher. Capital would flee the country: in Greece, it already has. But Germany would have none of those problems. With its huge trade surplus and limited debts, it has one of the strongest balance sheets of any major country. Its new currency would soar in value. Investors would flock to it. Meanwhile, the euro-minus-Germany would sink sharply, as investors rightly worried who was going to pay all the bills. That would make it a lot easier for the highly-indebted countries to export their way out of trouble.
Second, create two euros, one for northern Europe, and one for southern. The key problem with the euro, as plenty of analysts have pointed out, is that it is not a natural currency area. The economies that make it up are too different. When the euro was launched, it was thought that sharing a currency would draw them together, but there has been very little sign of that happening. If anything, they have sailed even further apart. The solution? Create two euros. One would include Germany, France, the Benelux countries, Finland and Austria. The other would include Italy, Greece, Spain, Portugal, Cyprus and Malta. A few nations might be hard to place: Ireland, Slovenia and Slovakia don’t fit obviously into either camp. But they could be offered a choice. The southern currency would depreciate sharply against the northern, but otherwise all the advantages of having a currency that straddles several countries could be maintained. The two new currency areas, however, would be far more natural than the single old one.
Three, create parallel national currencies. When the euro was being debated in the 1990s, the British floated the idea of parallel currencies. You’d have the euro, and national currencies, and both would be accepted as legal tender in each of the member sates of the European Union. Companies and individuals could chose which currency they wanted to strike a deal in. Countries would get back most of the advantages of having their own currencies. They could devalue when they wanted to. But the euro would survive. Initially it would mainly be a currency for big business, the capital markets, and for tourists. But if the euro area economies did finally converge, the euro might gradually push out national currencies. The difference would be that it would happen naturally, when the market was ready, rather than being forced on economies that couldn’t cope.
None of the options, naturally enough, is painless. Each would involve sacrifices. But any of them would be preferable to letting the euro collapse amid chaos.

Britain & The Euro

I've been arguing here for a while, and in my Bloomberg column, that the recession would re-open the case for Britain joining the euros. Wolfgang Munchau has a well argued piece in the FT today making precisely that case. Yesterday Will Hutton was making the argument in the Observer. I suspect this is going to grow. Sterling is in real trouble, and so will the British economy be in due course. The euro is going to be an obvious escape route. The problem will be that Gordon Brown will have spent so much money, and the accounting will be so dodgy, we probably won't qaulify. They let the Greeks in by fiddling the numbers. But I suspect the ECB won't want to take on responsibility for the catastrophic mess Brown in creating.

Italy & The Euro

I wonder how long the Italians will persist with the euro. Today we learnt that the country has entered its fourth recession in the past ten years. Before it adopted the single currency, Italy was doing pretty well. The establishment decided that the problem for the country, however, was its pernamently weak currency, and so enthusiastically swapped the lira for the euro. They turned out to be wrong. Italy did much better with a weak currency. It's so obvious that the euro has worked out badly for the Italians that at some point even the political class running the country must be able to figure it out.

Britain and the Euro

The maverick economist William Buiter has started a debate on whether Britain should join the euro, which has been picked up by Felix Salmon over on his blog. I predicted a few weeks ago in my Bloomberg column that the debate on the euro was about to re-start, so I'm pleased to see it happening. It's easy to dismiss the euro when 1) your currency is strong and 2) your economy is doing well. When those go into reverse, as they about to, then suddenly the euro will look a lot more attractive. I'm not convinced it is going to happen - not yet anyway - but the conversation is getting going again.